The case caught my eye because it involves a very
common fact pattern:
A small business owner obtains credit cards in his/her
personal name and uses it/them for business purchases and activities.
Question: Can the business deduct the interest on the
credit cards?
I doubt that there is a tax practitioner out there
that hasn’t deducted this, but a recent case points out minimum requirements in
case the IRS challenges the deduction.
Let’s look at C.A. Simmons, TC Memo 2026-34.
I admit that I was expecting some technical dive into
the interest deduction, but this case is not that. It is a reminder that one
has to get to first base before being able to reach home plate. Strike out and
the rest is meaningless.
Cathryn Simmons and her sister owned a specialty store
(called Stuff) in Kansas City, Missouri. They had sold handmade and small-batch
goods since 1996. As is too common, Stuff struggled to obtain credit in its own
name, so the sisters used personal credit cards and loans to finance the
business. They used QuickBooks for their accounting, and they did try to segregate
the credit cards between those used for business and those used personally.
COMMENT: I suspect most clients I have advised can
remember my standard sermon:
· Establish
a separate business account. Business deposits and expenses go through the
business account. Personal expenses do not. I understand that the bank is going
to charge for a business account, and it might be cheaper to lean into a
personal account. Do not do that. You already incurred that expense when you
started the business.
· I
understand that you might not be able to get a credit card in the business name
and may have to use a personal card. Use one card for business and the rest for
personal. Do not intermingle the two.
· If
you are using a personal card, I might have the business recognize it as a loan
from you. We will formalize it with a note, mention an interest rate and make
some reference to repayment. Do not be surprised if the interest rate on the
note is the same as the credit card.
· Keep
records of all business deposits and expenses. At a minimum, buy an expanding
file and file the paperwork by month. When we finish the tax return for the
year, combine the return and its paperwork into a file or folder for the year,
and hold onto it.
Back to Stuff.
The IRS looked at the 2017 business return and 2017 and
2019 personal returns. They expanded the business audit to include cost of
goods sold, advertising, vehicle expenses, travel, meals and entertainment, charitable
and promotion, and interest. We will discuss only the interest deduction today.
Stuff field a partnership return, and each sister’s share
of the 2017 business profit was less than $3 grand.
There was a little chop with the interest deduction
because it included both interest on the credit cards and interest on the
personal loans. I point it out because the Court says the following about the
personal loans:
As an initial matter, … fails to establish that the purported
interest amounts Stuff paid to her and her sister arose from Stuff’s own
indebtedness. The record contains promissory notes … but no ‘loan papers’
establishing Stuff’s indebtedness to the sisters.”
… we cannot conclude from these payments and the
sisters’ testimony that Stuff had an actual legal obligation to pay interest to
them.”
I get it but … harsh. I suppose Stuff was not following the terms of the promissory notes. We would - of course - redraft the terms of the notes. This is low hanging fruit.
What about the credit cards?
Ms. Simmons likewise fails to demonstrate that Stuff
was entitled to deduct the credit card interest and finance charges recorded on
its QuickBooks account. The evidence shows that Ms. Simmons obtained and used
credit cards in her own name to finance Stuff’s business expenses given its
inability to obtain credit on its own. Ms. Simmons fails to show that any
credit card interest and finance charges constituted Stuff’s own indebtedness
rather than her personal indebtedness, and thus no deduction is appropriate.”
Stop. I am having a problem here, as I am quite aware
of Reg 1.163-8T.
Seems to me that if (1) I trace a business expense
from the credit card statement to (2) the QuickBooks, I have at least a good chance
of meeting the requirement that “debt is allocated by tracing the disbursements
of the debt proceeds to specific expenditures.”
Back to the Court:
Assuming arguendo that credit cards opened by Ms. Simmons
constituted an indebtedness of Stuff, the records before us would not substantiate
the amounts claimed. Although the sisters testified that they used the six
designated credit cards exclusively for Stuff’s expenses, they failed to
establish the amounts and business purposes of the underlying expenditures that
resulted in the interest and finance charges at issue.”
They failed to establish the amounts and business purposes
…?
I believe two things happened here:
(1) Stuff could not document a lot of expenses. On
quick review, I see the IRS disallowing almost $13 grand of vehicle expenses,
$22 grand of charitable and promotion expenses, and so on.
(2) If those expenses ran through the credit
cards, then I understand an allocable portion of the interest being disallowed.
However, the Court just nixed the interest deduction altogether.
Seems to me that some of the credit card interest – that
allocable to deductions allowed – should be deductible. I presume the
accounting was not clean enough to do a side calculation. The IRS will rarely
play forensic, and the Tax Court certainly will not.
The Court did reemphasize that it wanted to see
linkage between the business activity and the credit cards, but that has been
the rule since I have been practicing. There is nothing new here. Somebody just
forgot to get on first base.
